● Banks and other financial institutions will consider this information a vital part of a new business plan and its inclusion will indicate good business sense.
● It may help a business to make important decisions about how to structure production, such as whether to produce its own components or whether to purchase them from external sources.
However:
● Break-even analysis is only as good as the data upon which it is based, and poor quality data may result in inaccurate conclusions. New businesses (particularly those which are quite different from their closest competitors) may have trouble finding suitable data upon which to base their calculations, greatly reducing the value of the break-even analysis.
● The model simplifies the realities of the market, failing to take into account the fact that firms may benefit from bulk buying inputs; that the firm may not sell all its output; or that it may not sell all its output at a single price.
‘Break-even analysis is of limited value to a start-up business because it ignores the market.’ To what extent do you agree with this statement?
● Break-even analysis does clearly illustrate the relationship between possible costs of production and the possible price of the product at various levels of output. This is a necessary starting point for many production decisions.
However:
● Break-even analysis is based on a simplified version of the market it does ignore many of its complexities, greatly reducing the value of the analysis for a start-up business.
For example:
– It cannot determine the actual sales of a product. Sales data is speculative. The analysis also
works on the assumption that all output is sold, and that there will be no fluctuations in
demand.
– It does not take into account variations in the price of inputs, such as discounts through bulk
buying.
– It does not take into account variations in the price of the product, such as through discounting.
● The value of break-even analysis may be limited when used in isolation, however, as one of a number of factors – including market research to indicate possible demand – it can help to create an overall picture of the market which can be of enormous value.
